Editor’s Note: In this series of articles, we include important or interesting videoclips with our comments. This
is an article that expresses our personal opinions about comments made
on Television and in Print. It is NOT intended to provide any investment
advice of any type whatsoever. No one should base any investing
decisions or conclusions based on anything written in or inferred from
this article. Investing is a serious matter and all investment decisions
should only be taken after a detailed discussion with your investment
advisor and should be subject to your objectives, suitability
requirements and risk tolerances.
Europe
What are you gonna do? This is a political struggle for the direction of Europe for next decade. It is not going to be resolved soon or without financial bloodshed. And like all European wars, it is likely to engulf the entire world. Not only did Germany print a slower number for Q3, Brazil’s 3rd Quarter showed a paltry growth of 0.3%.
Investment (FDI) can be a hidden transmission channel of the global crisis into Latin America, wrote Marcos Buscaglia of BAC-Merrill Lynch this week. That is true of all emerging markets we think. And European Banks have been the main source of credit to Emerging Markets as George Soros told CNBC’s Maria Bartiromo on September 21 (the European Banks had claims in EM of $3.5 trillion, the American Banks of $740 billion and Japanese Banks of $310 billion).
This massive credit channel from Europe to EM has dried up. The evidence?
The Bloom fades from the Lotus
Look at the stunning fall of the Indian Rupee, down 17-18% in the past month or two. The Indian Economy has become critically dependent on foreign capital inflows since 2006. It contracted the European disease after the last election. The Indian Government embarked on noble but unaffordable social programs of guaranteeing India’s poor with a minimum of 100 days of work. Then this security blanket was extended to a guarantee of a minimum level of free food and the next is a guarantee of minimum level of free health care.
Noble aims that appear riskless when credit is flowing in freely. But now India faces capital outflows, food inflation and increasing fiscal & current account deficits. Why wouldn’t the Rupee fall? We are not surprised. We wrote about the credit bubble in India on July 9, 2011 and on July 2, 2011.
But India is lucky to be not Europe. The fall in the Indian Rupee is a stablizing factor of sorts. It protects the local population from stresses imposed on Greeks & Italians by the shackles of a strong currency. And India does not have structural problems of low consumer demand or deflation. And the best time to invest in India has been when pessimism is widespread.
Is that time now? It really depends on Europe and the contagion it spreads globally in 2012.
But India is not the key to global growth. China is. And what is going on in China? Read the views of Jim Chanos in clip 1 below.
The Really Big Question
Last week, German Bunds began losing at least a bit of their safe haven status. The last two sessions of this week saw Japanese JGBs sell off a bit. Germany is relatively stable with 81% Debt to GDP. But do they retain the allure of safe Bunds if investors begin pricing in an eventual bailout/Euro Bond guarantee of sorts from Germany?
What about Japan? The problems of Japan’s debt have been an open secret. But the liquidity of the JGB market and the concentration of investor attention on Europe has pushed Japan concerns into the future. So why did the JGBs sell off a bit last week?
Are investors beginning to step back from Sovereign Debt in general? And if so, what about that Sovereign Debt beacon on the hill? We cannot judge whether a sell off in Bunds & JGBs should lead to a safe haven bid for Treasuries or whether Treasuries should sell off in sympathy with Bunds & JGBs?
To our rather simple mind, this may be the biggest question of all. As long as the ultimate risk free asset class in the world retains its safe haven allure, the world might be OK. But if and when Treasuries become a question mark? We shudder to think of the investing consequences.
No one expected anything real from the Super Committee, we have been told. But did the Treasury market expect more? Is it showing its disappointment? We don’t know. But we confess we are beginning to worry.
Featured Videoclips:
- Jim Chanos on Bloomberg TV’s In the Loop on Wednesday, November 23
- Mohamed El-Erian on Bloomberg TV’s In the Loop on Tuesday, November 22
- Larry Fink & Bill Gross on Bloomberg TV on Monday, November 21
1. Jim Chanos with Bloomberg’s Betty Liu – Wednesday, November 23
China can take us all up with its growth and stimulus or China could take us all down in 2012. The fate of China might rest on the stability of Chinese Banks. So what does Jim Chanos say about China & its banks? Read the excellent summary provided by Bloomberg below (emphasis ours):
Chanos on his recent trip to Hong Kong and Australia:
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“I think we probably came back a little bit more bearish….Our concerns about what we saw in Australia: an economy clearly tied to China has hitched its wagon to the tail of the tiger. In terms of the general complacency, what we heard over and over from investors and clients and potential clients is, ‘yes, yes, there are some excesses, but the government will figure out a way. That the government is this all-knowing, omniscient basic entity that will not (?) prevent me from losing money.”
Jim Chanos whether the Chinese government has money:
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“[The Chinese government] doesn’t [have money], and that’s the problem. The banking system in China is extremely fragile, and that’s one of the messages we wanted to get to people.”
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“In fact, because what happened the last two crises, in ’99 and ’04, when non-performing loans went crazy in China without even a recession, the Chinese banking system was not re-capitalized like ours was, it was papered over. Going into this credit expansion, Chinese banks are sitting on lots of bonds from the so-called asset management companies set up in 1999 and 2004, and they are keeping them on the books at par, at full value. In the case of Agricultural Bank of China, which we’re short, those restructuring receivables are equal to over 100% of their tangible book. The Chinese banking system is built on quicksand, and that’s the one thing a lot of people don’t realize. When they
talk about the foreign reserves of $3 trillion, what everybody forgets is there’s liabilities against that.” -
“Everybody seems to think it is a free and clear open checkbook. It’s not. That is what we have been trying to tell people. Focus on the lending system over there, because everything occurs through the banking system.”
On the Chinese economy:
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“Property prices and transactions are really beginning to decelerate. We saw that starting in August, that’s continued into November. Transactions are down 40% to 50% year over year in the tier 1 through 3 cities. Prices are down. In some cases, we’ve seen riots in sales offices, where people are amazed that prices could actually go down. There’s lots of indicators on the side. There’s a growing sense that the Chinese government will ease. We point out that credit this year will grow between 30% and 40% of Chinese GDP. If that’s tight, I’d hate to see it ease.”
On the scenario in which Chanos would cover his shorts in China:
- “At some point, we will cover our shorts. [The scenario would be] a system where the banking system would have to be recapitalized again, most likely. You would see a flood of RMB in the system, and a realization that the growth by fixed asset model has got to change. Mr. [Stephen] Roach and others are convinced that the Chinese customers will pick up the slack. And at some point, he and she will. But the transition is going to be the real tough part. And right now, the consumer continues to decline as a percent of the Chinese economy. That is, I think, flies right in the face of what most people think will happen.”
2. Mohamed El-Erian with Bloomberg’s Betty Liu & Dominic Chu – Tuesday, November 23
With respect, we do not consider Mr. El-Erian a prescient or credible predictor of either the economy or markets. He is not in the class of Lakshman Achuthan, David Rosenberg, Gary Shilling regarding either US economy or Asset Allocation. And he is not in the class of Jeff Gundlach, Kyle Bass regarding macro thinking.
But Mr. El-Erian is superb at articulating consensus thinking or what is about to be consensus thinking. He is an erudite speaker and his summations are worth reading. The best evidence is the summary below of his comments on Bloomberg TV (the emphasis are ours).
The most interesting comments below are about the Fed and collateral damage from QE3,
On the U.S. going into a double-dip recession:
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“I am worried. We’ve had two bits of unfavorable news in the last 24 hours. One you reported this morning, which is that we have less economic momentum than we thought we had – 2% growth as opposed to 2.5%. The second is that yesterday we had no policy momentum. We’re worried about the concept of stall speed, that 2% growth may not be enough for an economy that still has to de-lever. We put the chance of a recession at one-third to one half, which is really high given initial conditions.”
On policy makers in Washington, D.C.:
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“[Policy makers] are totally off the track. It’s not a failure to agree on medium-term fiscal reforms, it’s also a failure to give air cover for other things that need to be done — in housing, in the labor markets, in credit. We have no policy momentum. Let me tell you what I find most terrifying: we’re having this discussion about a risk of recession at a time when unemployment is already too high, at a time when a quarter of homeowners are underwater on their mortgages, at a time when the fiscal deficit is 9%, a time when interest rates are at zero.”
This is essentially what David Rosenberg said to Bloomberg’s Carol Massar & Matt Miller back on September 8 (see clip 3 of Videoclips of September 3 – September 9) :
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Rosenberg – It is problematic, We are in uncharted territory. Here we are talking
about 0% Fed Funds Rate going on for 3 years, a Fed balance sheet that
has tripled in the stratosphere and end-less fiscal stimulus. I mean FDR never ran a deficit over 6% of GDP in the New Deal, we already are running them 8-9% of GDP. Once the recession starts, my big dilemma is what is it that is going to pull us out? When you consider that China is fighting an inflation problem, Europe is fighting a sovereign debt problem, it is going to be very problematic what gets us out once we get into it.
On what factors could be driving a double-dip recession:
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“This is a fragile economy. It doesn’t mean we don’t have strength, we certainly do – the corporate sectors are as strong as we have ever seen it in terms of balance sheets. We have incredible entrepreneurial spirit. But we’re facing all these structural headwinds, and the big concern is the possibility of us being tipped over by Europe. Things in Europe, as you mentioned a few minutes ago, are getting worse, not better.”
On solutions in the U.S.:
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“Unlike Europe, the U.S. doesn’t face an engineering problem – it faces a political problem. The solution is not an engineering nightmare. You can actually put it on paper and get it done. But it’s been a political nightmare. What we’d like to see is the political class to come together and agree on the steps that need to be taken.”
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“As you have heard us say over and over again, Bill Gross has been saying it, I’ve been saying it, other PIMCO colleagues have been saying it — it’s structural in nature. We need medium term structural reforms to increase the growth potential and job creation potential of this economy. We can do it. This is different from Europe. Europe has both a political problem and an engineering problem. Our problems are small relative to Europe, but if we wait they will become larger.”
On the S&P’s statement that US rating is unaffected by the supercommittee:
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“That is what S&P is telling us. We have to remember that S&P still has us on negative outlook which means unless things improve over the next three years, there could well be another downgrade. The ratings agencies in general are in a very tough position. We talked about at PIMCO’s investment committee yesterday. They’ve been beaten up a lot, both for what they have done and for mistakes that disrupted the markets for a while. It is hard to be a ratings agency today. You have to read these comments in that context. They are under fire.”
On Joseph Stiglitz’s comments that austerity measures make the crisis worse:
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“I think [Stiglitz] is right, in the sense that the muddled middle, where Europe has been, is no longer sustainable. The crisis that started in the outer periphery, Greece, not only has shifted to the inner periphery and the outer core, Spain and Italy, but it has also impacted France which is the inner core.”
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“Europe needs to make a choice if it wants to save the euro, and it should save the euro. There’s only two choices: one is a full fiscal union, a political decision with a very large bill. The other [choice] is a smaller, less-than-perfect euro zone, which has political implications but has a smaller bill. That is a political decision that Germany must take. The quicker it takes it, the more likely it will be able to save the euro.”
On the options that could save Europe:
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“There are no easy options. That’s why the process is paralyzed. Wherever the policy makers look, they see tremendous costs and tremendous disruptions. The tendency has been to do too little, too late. There is no costless way forward at this point, and that is a problem that all of us have to internalize and understand, that there are no easy solutions.”
On Europe being the single biggest threat to the U.S. economy:
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“Left to our own, we would muddle along with the risk of stall speed, but one thing we cannot cope with is the major shock from one of the largest economic areas of the world, Europe. Already we’re seeing investors stepped back from markets because of the anxiety. The more that happens, the more dysfunctional these markets become.”
On whether the Fed should implement QE3:
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“I smiled when one of your guests said earlier that the Fed has been the only adult in Washington. That is true. It has been the only institution willing to take steps. As you pointed out, because the Fed has taken these steps, it has taken pressure off of the rest of Washington to do its part…Other agencies haven’t stepped up to the plate. It is time for other agencies to step up. The effectiveness of the Fed is declining, unfortunately, day in and day out.”
On what the Fed should do:
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“Chairman Bernanke has made it clear and he’s repeating it three times, saying that when they look at these unconventional policies, they recognize the benefits but there are costs and risks. What we call collateral damage, unintended consequences.”
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“[Bernanke] recognizes that that equation, that balance, is shifting from potential benefits to costs and risks. Looking forward, if they were to do QE3, they may get some benefits, but I suspect there would also be quite a bit of collateral damage and distortions put into the system that would take us years to overcome.”
- “[Collateral damage would be] pressure on the currency. What you will see is pressure on the functioning of markets, you will see people stepping back, because more and more non-commercial forces will be determining market outcomes. We will also see questions about the credibility of the Fed and the political autonomy of the Fed.”
3. Larry Fink & Bill Gross together with Bloomberg’s Erik Schatzker at UCLA Anderson School of Management – Monday, November 21
The actual conversation took place on Thursday, November 17 but it was aired on Monday, November 21. The videos can be seen at:
The detailed summary below is courtesy of Bloomberg TV (emphasis ours):
Fink on whether now is an appropriate time to be taking risk:
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“If you have the fortitude to look beyond the next cycle of information, if you have the fortitude to look beyond the next few years, and then you have the capability of investing for 10-year cycles, then a larger allocation in equities will probably pay off. But it’s going to have to be with equities that are multinational in nature so you’re not country dependent. And that’s one of the real themes that we’re talking about. Don’t be so U.S. dependent. Don’t be so China dependent. Try to get companies — that’s the beauty of corporations. They are in multiple locations throughout the world, and their earnings streams are less dependent on one nation.”
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“And so I do believe one has to accept more risk today. And I think the PE ratios of the world are pricing in that fear. And so in my mind, even today, I’m very worried about Europe and the resolution of Europe. I do believe a larger than normal allocation in global equities with a bias towards dividend will pay off over a long cycle.”
What is the composition of Mr. Fink’s personal assets, outside of his BlackRock stock? Inquiring minds want to know.
Gross on risk:
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“Here’s the critical factor as I see it. Can developed economies successfully reflate? Can the Bernanke helicopter stay aloft? Can we produce a nominal GDP growth rate, whether it’s laden significantly with inflation or more significantly with real growth? But can we produce an old normal economy of four to five percent nominal growth? You know, it’s not necessarily a slam dunk that we can. Japan has proven that for the past several decades. There are two lost decades.”
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“The critical element in terms of risk taking going forward is to decide whether or not developed economies can successfully reflate. If they cannot, then — then a higher quality, safer choice is the best alternative. If they can, then obviously equities, which can cope with inflation, which can produce growth in a reflationary environment is the better choice. But it’s critical going forward. And an investment company and an investor must, you know, attempt to make that decision on an annual type of basis because the outcome is not determined at the moment.”
Gross on how he’s investing his own money:
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“A barbell mix of both. I have a substantial amount of bonds. You know, not treasury bonds. In many cases, municipal bonds. But I have a decent mix in terms of global growth companies. I once suggested if we can successfully reflate, and that’s the barbell alternative on the optimistic side, then a Procter or a Johnson & Johnson or a Coca-Cola, a global company with half of their revenues coming from outside the United States, with dividends of three and a half to four percent and at least with some growth prospects, obviously much better than a treasury. But that’s a choice that you shouldn’t make with a hundred percent certainty. That’s a choice that you should make with the potential for a deflationary outcome, minimal as it might be in the minds of policy makers.”
Gross on what he would take from BlackRock to make it a part of PIMCO:
- “I’d take their ETF fr
anchise. I don’t know if it’d pay for it but I’d certainly take it if I could take the best of Blackrock. That’s an area where PIMCO has not been struggling but it has been behind, and we’re coming public with our actively managed total return fund in the next few months, the SEC willing. So it’s an area I guess that we’re trying to emphasize. I’d also appreciate and would welcome their equity franchise, but PIMCO’s trying to become more balanced from the standpoint of being a bond shop to being equally balanced not only domestically and globally but from the standpoint of equity.”
Fink on entrepreneurship and job creation in the U.S.:
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“The entrepreneurialism of the country is quite unique. You know, we are still a nation that has created the Facebooks, the PIMCOs, the Googles, the Apples, the Bloombergs. You know, we are still the intellectual capital of the world when it comes to software development. We are the innovator of medical research still. There are so many things. So much of this does not create as many jobs as it used to. We’ve had enormous success in productivity and that productivity is a way for us to be differentiated versus the China and the other places. And all the other countries have this same issue of productivity and how it impacts jobs….I see all the same pitfalls, all the same problems. And the problems are enormous.”
Gross on entrepreneurship and job creation in the U.S.:
- “The problem I have in terms of job creation, yes, we have Facebook and Google and Apple, and it’s been significant in terms of profit creation. But it hasn’t been significant in terms of job creation. And to a certain extent, yes, the entire world is subject to this problem of technology in which we are basically raging against the machine, so to speak, the technology machine. In a sense, the creative destruction is applicable from the standpoint of destruction. But from the standpoint of job creation not necessarily so. There are wonderful benefits from Facebook and Google and our iPads. But we’re not seeing it in terms of job creation going forward. And that creates a weakness not just in the United States, but globally.”
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